nep-cba New Economics Papers
on Central Banking
Issue of 2013‒10‒11
eighteen papers chosen by
Maria Semenova
Higher School of Economics

  1. Governing the banking industry: A severe case of supervisory failure By Martín Lagos
  2. Monetary Policy Frameworks in Asia : Experience, Lessons, and Issues By Peter J. Morgan
  3. Is Bank Debt Special for the Transmission of Monetary Policy? Evidence from the Stock Market By Filippo Ippolito; Ali K. Ozdagli; Ander Perez
  4. What now for monetary policy? By John H. Makin
  5. Banking Globalization, Transmission, and Monetary Policy Autonomy By Linda S. Goldberg
  6. The European Central Bank in the age of banking union By Zsolt Darvas; Silvia Merler
  7. Banking union:a solution to the euro zone crisis ? By Maylis Avaro; Henri Sterdyniak
  8. Central bank liquidity auction mechanism design and the interbank market By Ollikka, Kimmo; Tukiainen , Janne
  9. Midas, transmuting all, into paper: The Bank of England and the Banque de France during the Revolutionary and Napoleonic Wars By Chadha , Jagjit S.; Newby, Elisa
  10. Systemic Risk Score: A Suggestion By Christophe Hurlin; Christophe Pérignon
  11. Banking Union: integrating components and complementary measures By Santiago Fernandez de Lis; Ana Rubio; Jorge Sicilia
  12. The Common Component of CPI: An Alternative Measure of Underlying Inflation for Canada By Mikael Khan; Louis Morel; Patrick Sabourin
  13. Currency Union with and without Banking Union. By Bignon, V.; Breton, R.; Rojas Breu, M.
  14. China's Capital Controls - Through the Prism of Covered Interest Differentials By Yin-Wong Cheung; Risto Herrala
  15. Current-Account Adjustments and Exchange-Rate Misalignments By Blaise Gnimassoun; Valérie Mignon
  16. Modeling Hyperinflation Phenomenon: A Bayesian Approach By Rolando Gonzales Martínez; Last: Gonzales Martínez
  17. Sovereigns versus Banks: Credit, Crises, and Consequences By Òscar Jordà; Moritz HP. Schularick; Alan M. Taylor
  18. Financial market regulation in the shadow of the sovereign debt crisis By Mayntz, Renate

  1. By: Martín Lagos
    Abstract: After summarizing the birth and basic notions of credit, money and banking, sections 1 to 4 review the extraordinary potential, but also the substantial core risks of fractional reserve banking. The appearance of central banks, fiduciary monies, prudential regulation and supervision, as well as technological change, had huge impact on banking, but its basic business model remained the same old, risky one. Sections 5 and 6 describe how the contagion risk proper of the opaqueness and informational asymmetries of commercial banking plus the external diseconomies associated to systemic crises have justified the growth of thick safety nets, guarantees and government involvement in critical situations. These realities require not only top-level technical expertise in the supervisory bodies, but also outstanding moral integrity and political independence within their heads. Sections 7 and 8 pretend to summarize the key factors surrounding the subprime mortgage lending bubble and the supervisory failure leading to the worst economic crisis in seventy years.
    Date: 2013–09
  2. By: Peter J. Morgan (Asian Development Bank Institute (ADBI))
    Abstract: This paper analyzes the evolution of East Asian monetary policy frameworks over the past two decades, chiefly in response to shocks from the Asian financial crisis of 1997–1998 and the global financial crisis (GFC) of 2007–2009. The Asian financial crisis showed the importance of exchange rate flexibility and credible policy frameworks, leading to increased central bank independence, greater focus on inflation policy and more flexible exchange rates. A key lesson of the GFC was the importance of containing systemic financial risk and the need for a “macroprudential†approach to surveillance and regulation that can identify system-wide risks and take appropriate actions to maintain financial stability. Emerging economies face particular challenges because of their underdeveloped financial systems and vulnerability to volatile international capital flows, especially “sudden stops†or reversals of capital inflows. The paper reviews the history of East Asian monetary policy frameworks since 1990; describes current monetary policy frameworks, including issue of price versus financial stability for a central bank and the policies a central bank can use to manage financial stability; the monetary policy transmission mechanism based on financial linkages and financial deepening; assesses policy outcomes including inflation targeting and responses to the “Impossible Trinityâ€; and makes overall conclusions. The paper finds that East Asian central banks have generally managed inflation and growth well over the past decade, but the difficulties faced by central banks of advanced countries in the aftermath of the GFC suggests that not all problems have been solved yet.
    Keywords: Monetary policy framework, Asia, Asian financial crisis, central bank independence, Capital Inflows, inflation policy
    JEL: E52 E58 F31 F32 G18
    Date: 2013–09
  3. By: Filippo Ippolito; Ali K. Ozdagli; Ander Perez
    Abstract: We combine existing balance sheet and stock market data with two new datasets to study whether, how much, and why bank lending to firms matters for the transmission of monetary policy. The first new dataset enables us to quantify the bank dependence of firms precisely, as the ratio of bank debt to total assets. We show that a two standard deviation increase in the bank dependence of a firm makes its stock price about 25% more responsive to monetary policy shocks. We explore the channels through which this effect occurs, and find that the stock prices of bank-dependent firms that borrow from financially weaker banks display a stronger sensitivity to monetary policy shocks. This finding is consistent with the bank lending channel, a theory according to which the strength of bank balance sheets matters for monetary policy transmission. We construct a new database of hedging activities and show that the stock prices of bank-dependent firms that hedge against interest rate risk display a lower sensitivity to monetary policy shocks. This finding is consistent with an interest rate pass-through channel that operates via the direct transmission of policy rates to lending rates associated with the widespread use of floating-rates in bank loans and credit line agreements.
    Keywords: bank lending channel, monetary policy transmission, firm financial constraints, bank financial health, floating interest rates
    JEL: G21 G32 E52
    Date: 2013–09
  4. By: John H. Makin (American Enterprise Institute)
    Abstract: Although the Fed’s original purpose was primarily to provide liquidity during financial crises and ensure a low and stable rate of inflation, it is now expending more energy on targeting lower unemployment and higher growth. Monetary policy, however, is ill-suited to achieving these goals.
    Keywords: the Federal Reserve,Monetary policy,Federal reserve policy,Economic outlook
    JEL: A E
    Date: 2013–10
  5. By: Linda S. Goldberg
    Abstract: International financial linkages, particularly through global bank flows, generate important questions about the consequences for economic and financial stability, including the ability of countries to conduct autonomous monetary policy. I address the monetary autonomy issue in the context of the international policy trilemma: countries seek three typically desirable but jointly unattainable objectives: stable exchange rates, free international capital mobility, and monetary policy autonomy oriented toward and effective at achieving domestic goals. I argue that global banking entails some features that are distinct from broad issues of capital market openness captured in existing studies. In principal, if global banks with affiliates established in foreign markets can reduce frictions in international capital flows then the macroeconomic policy trilemma could bind tighter and interest rates will exhibit more co-movement across countries. However, if the information content and stickiness of the claims and services provided are enhanced relative to a benchmark alternative, then global banks can weaken the trilemma rather than enhance it. The result is a prediction of heterogeneous effects on monetary autonomy, tied to the business models of the global banks and whether countries are investment or funding locations for those banks. Empirical tests of the trilemma support this view that global bank effects are heterogeneous, and also that the primary drivers of monetary autonomy are exchange rate regimes.
    JEL: E44 F36 G32
    Date: 2013–10
  6. By: Zsolt Darvas; Silvia Merler
    Abstract: During the crisis the European Central Bankâ??s roles have been greatly extended beyond its price stability mandate. In addition to the primary objective of price stability and the secondary objective of supporting EU economic policies, we identify ten new tasks related to monetary policy and financial stability. We argue that there are three main constraints on monetary policy: fiscal dominance, financial repercussions and regional divergences. By assessing the ECBâ??s tasks in light of these constraints, we highlight a number of synergies between these tasks and the ECBâ??s primary mandate of price stability. But we highlight major conflicts of interest related to the ECBâ??s participation in financial assistance programmes. We also underline that the ECBâ??s government bond purchasing programmes have introduced the concept of â??monetary policy under conditionalityâ??, which involves major dilemmas. A solution would be a major change towards a US-style system, in which state public debts are small, there are no federal bail-outs for states, the central bank does not purchase state debt and banks do not hold state debt. Such a change is unrealistic in the foreseeable future.
    Date: 2013–10
  7. By: Maylis Avaro (ENS Cachan); Henri Sterdyniak (Ofce)
    Abstract: The banking union emerged from the June 2012 European Council as a new project expected to help and solve the euro area crisis. Is banking union a necessary supplement to monetary union or a new rush forward? The banking union would break the link between the sovereign debt crisis and the banking crisis, by asking the ECB to supervise banks, establishing common mechanisms to solve banking crises, and encouraging banks to diversify their activities. The banking union project is based on three pillars: a Single Supervisory Mechanism (SSM), a Single Resolution Mechanism (SRM) a European Deposit Guarantee Scheme. Each of these pillars raises specific problems. Some are related to the current crisis (can deposits in euro area countries facing difficulties be guaranteed?); some other are related to the EU complexity (should the banking union include all EU member states? Who will decide on banking regulations?),some other are related to the EU specificity (is the banking union a step towards more federalism?), the more stringent are related to structural choices regarding the European banking system. The banks' solvency and their ability to lend would primarily depend on their capital ratios, and thus on financial markets' sentiment. The links between the government, firms, households and domestic banks would be cut, which is questionnable. Will governments be able tomorrow to intervene to influence bank lending policies, or to settle specific public banks? An opposite strategy could be promoted: restructuring the banking sector, and isolating retail banking activity from risky activities. Retail banks would focus on lending to domestic agents, and their solvency would be guaranteed because they would not be allowed to run risky activity.Can European peoples leave such strategic choices in the hands of the ECB?
    Keywords: Banking un, Eion, European Construction
    JEL: G21 G28
    Date: 2013–09
  8. By: Ollikka, Kimmo (Government Institute for Economic Research); Tukiainen , Janne (Government Institute for Economic Research and Helsinki Center of Economic Research)
    Abstract: We study whether the mechanism design in the central bank liquidity auctions matters for the interbank money market interest rate levels and volatility. Furthermore, we compare different mechanisms to sell liquidity in terms of revenue, efficiency and auction stage interest rate levels and volatility. Most importantly, we ask which mechanism is the best at implementing the target policy interest rates to the interbank market and what are the trade-offs involved. We construct a relatively general model of strategic bidding with interdependent valuations, and combine it with a stylized model of the interbank market. The novel feature of the model is that the expectations of the interbank market outcomes determine the valuations in the liquidity auctions. The model captures the relevant features of how the European Central Bank sells liquidity. We use simulations to compare discriminatory price, uniform price and Vickrey auctions to a posted price mechanism with full allotment. In order to analyze interactions between the primary and the secondary market under four different mechanisms, we need to make a lot of assumptions and simplications. Given this caveat, we find that posted prices with full allotment is clearly the superior alternative in terms of implementing the policy interest rate to the interbank markets. This comes at the cost of less revenue compared to the revenue maximizing discriminatory price auction, but surprisingly, will not result in efficiency losses compared even to the Vickrey auction.
    Keywords: ECB liquidity auctions; interbank markets; mechanism design; multi-unit auctions; monetary policy; posted-prices
    JEL: C63 C72 D02 D44 D53 E43 E44 E52 E58 G21
    Date: 2013–09–17
  9. By: Chadha , Jagjit S. (Keynes College, University of Kent, Canterbury); Newby, Elisa (Bank of Finland, Monetary Policy and Research Department)
    Abstract: This paper assesses Revolutionary and Napoleonic wartime economic policy. Suspension of gold convertibility in 1797 allowed the Bank of England to nurture British monetary orthodoxy. The Order of the Privy Council suspended gold payments on Bank of England notes and afforded simultaneous protection to the government and the Bank in pursuit of the conflicting goals of price stability and war finance. The government, the Bank of England and the commercial banks formed a loose alliance drawing on due political and legal processes and also paid close attention to public opinion. We suggest that the ongoing solvency of the Bank of England was facilitated by suspension and allowed the Bank to continue to make substantial profits throughout the Wars. It became acceptable for merchants to continue to trade with non-convertible Bank of England notes and for the government to finance the war effort, even with significant recourse to unfunded debt. These aspects combined to create a suspension of convertibility that did not undermine the currency. By contrast, the Assignats debacle had cost the French monetary system its reputation in the last decade of the 18th century and so Napoleonic .finance had to evolve within a more rigid and limiting framework.
    Keywords: monetary orthodoxy; suspension of convertibility; war finance
    JEL: C61 E31 E42 E58 N13
    Date: 2013–09–16
  10. By: Christophe Hurlin (LEO - Laboratoire d'économie d'Orleans - CNRS : UMR6221 - Université d'Orléans); Christophe Pérignon (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - GROUPE HEC - CNRS : UMR2959)
    Abstract: We identify a potential bias in the methodology disclosed in July 2013 by the Basel Committee on Banking Supervision (BCBS) for identifying systemically important financial banks. Contrary to the original objective, the relative importance of the five categories of risk importance (size, cross-jurisdictional activity, interconnectedness, substitutability/financial institution infrastructure, and complexity) may not be equal and the resulting systemic risk scores are mechanically dominated by the most volatile categories. In practice, this bias proved to be serious enough that the substitutability category had to be capped by the BCBS. We show that the bias can be removed by simply standardizing each input prior to computing the systemic risk scores.
    Keywords: Systemic risk ; score ; G-SIFIs
    Date: 2013–09–27
  11. By: Santiago Fernandez de Lis; Ana Rubio; Jorge Sicilia
    Abstract: The crisis has led to increased financial fragmentation and revealed the link between sovereign and national banking risks, whose persistence over time would be incompatible with the euro. The solution to these problems must be the banking union, which should be constructed at the same time as the current crisis is being resolved. The process will be eventually complemented by the creation of cross-border banks. The process of the banking union does not have an optimal design, it will be long and will generate tensions during the transition period, but it is politically feasible. In the end, we will have a Europe that is much more integrated from the monetary, banking, fiscal and political points of view.
    Keywords: banking union, Europe, supervision, fragmentation
    JEL: F33 F34 F36 G18 G21
    Date: 2013–08
  12. By: Mikael Khan; Louis Morel; Patrick Sabourin
    Abstract: In this paper, the authors propose a measure of underlying inflation for Canada obtained from estimating a monthly factor model on individual components of the CPI. This measure, labelled the common component of CPI, has intuitive appeal and a number of interesting features. In particular, it is not affected by sector-specific price movements that can distort the signal in many other measures of underlying inflation, and appears to capture price movements that are indicative of aggregate demand fluctuations in the Canadian economy. This indicator may serve as a useful complement to existing measures of underlying inflation monitored by the Bank of Canada.
    Keywords: Business fluctuations and cycles; Econometric and statistical methods; Inflation and prices; Monetary policy framework
    JEL: C1 E31 E32 E52 E58
    Date: 2013
  13. By: Bignon, V.; Breton, R.; Rojas Breu, M.
    Abstract: This paper analyzes a two-country model of currency, banks and endogenous default to study whether impediments to credit market integration across jurisdictions impact the desirability of a currency union. We show that when those impediments induce a higher cost for banks to manage cross-border credit compared to domestic credit, welfare may not be maximal under a regime of currency union. But a banking union that would suppress hurdles to banking integration restores the optimality of that currency arrangement. The empirical and policy implications in terms of banking union are discussed.
    Keywords: banks, currency union, credit, default, limited commitment.
    JEL: E42 E50 F3 G21
    Date: 2013
  14. By: Yin-Wong Cheung (City University of Hong Kong and Hong Kong Institute for Monetary Research); Risto Herrala (Bank of Finland)
    Abstract: We study the renminbi (RMB) covered interest differential - an indicator of the effectiveness of capital controls. It is found that the differential is not shrinking over time and, in fact, appears larger after the global financial crisis than before. That is, capital controls in China are still substantial and effective. In addition to exchange rate changes and volatilities, the RMB covered interest differential is affected by credit market tightness indicators. The marginal explanatory power of these macroeconomic factors, however, is small relative to the autoregressive component and the dummy variables that capture changes in China's policy.
    Keywords: NDF Implied RMB Interest Rate, Capital Controls, Asymmetric Response, Macro Determinants, Credit Market Tightness
    JEL: E44 F31 F32
    Date: 2013–09
  15. By: Blaise Gnimassoun; Valérie Mignon
    Abstract: This paper aims at studying current-account imbalances by paying a particular attention to exchange-rate misalignments. We rely on a nonlinear model linking the persistence of current account imbalances to the deviation of the exchange rate to its equilibrium value. Estimating a panel smooth transition regression model on a sample of 22 industrialized countries, we show that persistence of current-account imbalances strongly depends on currency misalignments. More specifically, while there is no persistence in cases of currency undervaluation or weak overvaluation, persistence tends to augment for overvaluations higher than 11%. In addition, whereas disequilibria are persistent even for very low overvaluations in the euro area, persistence is observed only for overvaluations higher than 14% for non-eurozone members.
    Keywords: Current-account imbalances;current-account persistence;exchange-rate misalignments;panel smooth transition regression models
    JEL: F32 F31 C33
    Date: 2013–09
  16. By: Rolando Gonzales Martínez; Last: Gonzales Martínez (Unidad de Análisis de Políticas Económicas y Sociales, Bolivian Government)
    Abstract: Hyperinflations are short-lived episodes of economic instability in prices which characteristically last twenty months or less. Classical statistical techniques applied to these small samples could lead to an incorrect inference problem. This paper describes a Bayesian approach for modeling hyper-inflations which improves the modeling accuracy using small-sample inference based on specific parametric assumptions. A theory-congruent model for the Bolivian hyperinflation was estimated as a case study.
    Keywords: Hyperinflation, Bayesian methods
    JEL: E31 C11
    Date: 2013–04
  17. By: Òscar Jordà; Moritz HP. Schularick; Alan M. Taylor
    Abstract: Two separate narratives have emerged in the wake of the Global Financial Crisis. One speaks of private financial excess and the key role of the banking system in leveraging and deleveraging the economy. The other emphasizes the public sector balance sheet over the private and worries about the risks of lax fiscal policies. However, the two may interact in important and understudied ways. This paper studies the co-evolution of public and private sector debt in advanced countries since 1870. We find that in advanced economies financial stability risks have come from private sector credit booms and not from the expansion of public debt. However, we find evidence that high levels of public debt have tended to exacerbate the effects of private sector deleveraging after crises, leading to more prolonged periods of economic depression. Fiscal space appears to be a constraint in the aftermath of a crisis, then and now.
    JEL: C14 C52 E51 F32 F42 N10 N20
    Date: 2013–10
  18. By: Mayntz, Renate
    Abstract: The financial market crisis of 2008/2009 triggered efforts at re-regulation at all political levels, national, European, and international. Reform demands had been radical and comprehensive but effective regulatory change was halting, and then in summer 2011 the related connected sovereign debt and euro crises came to preoccupy political attention. Regulatory financial market reform nevertheless continued. This paper traces both the shift in political attention and the continuing regulatory activities of different bodies between the summer of 2011 and the summer of 2013. The analysis highlights the time profile, the specific selectivity, the recursive nature, and the stepwise concretization of reforms. Finally, the issue is raised whether the reform process will eventually lead to increasing regulatory harmonization, or increasing international diversity of financial market regulation. -- Die Finanzmarktkrise von 2008/2009 hat auf allen politischen Ebenen - der nationalen, europäischen und internationalen - Versuche einer Regulierungsreform ausgelöst. Die anfänglichen Reformziele waren radikal und umfassend, aber der tatsächliche Reformprozess kam bis zum Sommer 2011 nur zögernd voran. Zu diesem Zeitpunkt drängte die Staatsschuldenkrise und die mit ihr verbundene Euro-Krise das Thema Finanzmarktregulierung in den Hintergrund. Das Discussion Paper verfolgt sowohl den Wandel politischer Aufmerksamkeit wie die dennoch weiter laufenden Aktivitäten wichtiger, speziell internationaler Institutionen in Sachen Regulierungsreform in der Zeit zwischen Mitte 2011 und Mitte 2013. Es wird gezeigt, dass der Reformprozess eine charakteristische Zeitstruktur, eine spezifische Selektivität und Rekursivität besitzt und durch eine schrittweise Konkretisierung gekennzeichnet ist. Am Ende stellt sich die Frage, ob der Reformprozess zu wachsender internationaler Harmonisierung oder umgekehrt zu wachsender Diversität von Finanzmarktregulierung führen wird.
    Date: 2013

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